Business Estate Planning Overview Presented by Leon Lewis

Business Estate Planning Overview Presented by: Leon Lewis, B. A. , LL. B. , CLU

BUSINESS ESTATE PLANNING “Family businesses help to fuel the worlds economy and Canada’s economy” Family business are also at risk. . Why? Sometimes they fail to plan. . . no retirement or estate plan for the current leader, no contingency plan for disability or death. Their Achilles heel appears to be planning, or more accurately, the lack of planning. ” “The First Success Readiness Survey of Canadian Family – Owned Business” 1999 by University of Waterloo & Deloitte & Touche Centre for Tax Education & Research 2

Why Plan? • Accumulate, preserve and pass on your wealth • Plan for your retirement/business succession • Maximize wealth by minimizing taxes – During your lifetime – On your death – On income earned after your death • Ensure your family will be provided for in the event of an untimely death/disability • Meet your other objectives including philanthropy and the distribution of your assets in accordance with your wishes 3

Business owners have greater estate planning needs than other taxpayers • The corporation is the family’s most important asset • The corporation needs to be protected against: – Loss of the key person – Cost of buying out a partner’s shares – Impact of untimely debt repayments and tax • The need for exit strategies and business succession 4

Fortunately there a number of tax concessions and planning tools/strategies available to corporate shareholders For example: • • • The Small Business Capital Gains Exemption The Small Business Tax Limit ($ 500, 000) The Capital Dividend Account (CDA) Corporate-owned life Insurance Shared ownership (split) – split beneficiaries Corporate Reorganizations (Estate Freezes) Income Splitting/Owner – Manager remuneration planning Buy-Sell/insurance planning Will and Probate planning Charitable giving strategies Pensions Trusts 5

Role of the Estate Planning Team • The life insurance advisor always has a role in the planning process • Sometimes as the catalyst and facilitator • Most times as part of the team working with your accountant and lawyer* • Always the one to introduce the topic of death and disability into the planning equation with the specialized knowledge in the application of life insurance products with planning strategies in maximizing the funding and tax benefits *Our role is to help clients take control of their financial lives. In a world crowded with changes and volatile economic cycles, more clients are looking for clear direction and planning. 6

Corporate-Owned Life Insurance It is less costly than individually owned Before-tax income needed to net $10, 000 Individual $10, 000 tax-rate 46. 4% 1 -46. 4% = $18, 657. 00 Corporate $10, 000 = $12, 285. 00 tax-rate 18. 5% 1 -18. 5% The Annual Savings is $6, 372. 00 Unique Attributes: • Timing – On the death of a shareholder, the very contingency that triggers the obligation to buy the shares, creates the needed capital • Tax savings – Life insurance has the unique ability, when the CDA is used, to eliminate or reduce the tax otherwise payable by the estate on the capital gain arising on the death of the shareholder (corporation redemption). Not only funding 1 -3% • Fully guaranteed • Liquidity – preserves estate against erosion of tax on death 7 • Equalization funding

Planning • Not an event, but a process • No textbook ‘one size fits all’ plan • Each situation is different – depends on your current situation, you values, your goals and needs • Considerations include the future plans for the business such as a sale, succession, etc. • Regular reviews THE BEST PLAN IS THE ONE YOU IMPLEMENT. . . In the knowledge that it tailor-made by you and your life insurance advisor working with your accountant and lawyer 8

Contingency – Risks “Eliminate Debt on Death” – Collateral Insurance • • • Growth and expansion in business is usually funded by debt Banks insist that business owners sign for loans – not once but twice – on behalf of the corporation and in their personal capacity (also spouse) Result – bank has lien not only on business assets but also the personal estate of the signatures. Solution: Life insurance collaterally assigned to the creditor • On death, the loan repaid with insurance proceeds and CDA still credited • Lesser of premiums or net cost of insurance is tax deductible (exception) • Can avoid potential share value increase. Your family and not the bank become the first heirs to your business and personal assets 9

Key Person • The most valuable asset of your business is the people whose management ability determine its success – intellectual property • The ‘key person’ policy insures against the loss of profits if the business is suddenly deprived (death/disability) of his or her knowledge, managerial skill, ability and experience • It cushions the impact of the financial shock to business operations • It funds the search for a qualified successor NOTE: Life insurance is multi-purpose e. g. the key person policy can serve to also fund retirement and buy/sell commitments. 10

Succession Plans Where two or more shareholders • Shareholders buy/sell agreement important • Focus on four main areas: – What happens to shares of deceased shareholders – How are the shares valued – The treatment of the life insurance funding 11

Succession Plans. . . Where two or more shareholders • Tax planning essential in preparation of the agreement. Depends on factors unique to each situation e. g. Qualification for the capital gains exemption and for ‘grandfathering’ under the stop-loss rules • Flexibility in the drafting of the shareholders agreement important • Share valuation provisions and formulas should be unambiguous • A Shareholders disability should be addressed • Post stop-loss strategies require planning • Insurance personally or corporately owned? 12

Funding the Tax on Death • Avoids forced sale of Corporation due to lack of planning and liquidity • Redemption of frozen preferred shares before death may significantly reduce tax on death • Charitable donations will reduce tax on death • Tax free life insurance proceeds for liquidity – Ownership (corporate vs. personal) • Proceeds used to redeem shares or pay tax 13

Funding the Tax on Death. . . Reduce the amount of final tax bill through use of corporateowned life insurance. • Defer up to 100% of tax if grandfathered or if rollover to spouse • Otherwise, reduce tax by roughly one-half • But careful planning is required. To avoid all stop-loss rules 14

Family Owned Business Succession planning provides a number of opportunities for tax planning. Without planning the tax cost of intergenerational transfer of ownership would be prohibitive. The Estate Freeze The cornerstone of Canadian estate/succession planning. Technique is to ‘freeze’ value you have in the shares of your company and pass the future growth in the company to others (usually the next generation) – Process involves shareholders converting common (growth) shares of company for fixed value preferred shares – Usually choose a discretionary trust to hold new common shares as it allows greatest flexibility – Fixes the capital gain arising on death of shareholder based on value at time of freeze – Capital gain can be reduced on redemption of shares – Freeze continues to control corporation after freeze – Can freeze all or part of future growth – $750, 000 capital gains exemption is still available – Consider crystallizing capital gains exemption now to lock in future tax savings – Defers the tax payment – Fund the cost of redemption of preferred shares and tax on death with life insurance – Life insurance (often joint with spouse) provides liquidity. 15

Retirement Planning What about you? You have conscientiously planned for the preservation and transfer of your business and estate but have you planned for your retirement? Who should pay you a pension? Planning for retirement is fundamental and critical. Business Retirement Plan a)Individual Pension Plan (IPP) - A registered defined benefit plan for business owners and executives. Can have one member. - Provides individuals age 55 and over, funding substantially in excess of RRSP limits, particularly in year one of the plan. - Main advantage of IPP is increased retirement income through increased tax deductible contributions and accumulation of tax deferred funds. - Creditor proof. 16

Retirement Planning b) Retirement Compensation Arrangement (RCA) - Attractive and tax-effective way to compensate ownermanagers in retirement, by deferring current income, tax and establishing retirement funds at the same time. - A flexible unregistered private pension trust to which an employer corporation can make “reasonable” deductible contributions. - The corporation pays a refundable 50% tax on contributions and taxable earnings and recovers the tax when distributions are made to the beneficiary - RCA fund invested in tax-exempt life insurance to prevent payment of more refundable tax. 17

Retirement Planning Retirement Compensation Arrangement (RCA). . . used - The insurance asset, in trust, plus the refundable tax asset are as collateral to borrow up to 90% of the original investment, for reinvestment stock in the business. - Helps to keep the profits down to quality for the small business tax rate. back - RCA leveraging is superior to the normal bonus down and loan practice - Creditor Proof - Low risk/low administration/payroll tax savings - Tax bracket management in retirement – reduced to 15% if 18

Retirement Planning c) Tax-Exempt Life Insurance - Take retained profits or surplus cash within your company that you are not spending and reallocate them into a vehicle that provides tax-deferred growth and ultimately, a tax-free benefit - Life insurance provides the opportunity to tax-shelter and accumulate wealth and maximize the ultimate value of the corporate assets (Opco or Holdco) for your beneficiaries 19

Retirement Planning Tax-Exempt Life Insurance. . . - By moving assets from a taxable environment into a tax-sheltered vehicle, you can enhance your current financial/estate plan by: - Providing additional protection for your family - Investing money on a tax-sheltered basis - Supplementing your retirement income - Increasing the value of your corporation’s assets that will ultimately go to your family - Disability – Fund tax-free Major accounting firms now make reference to life insurance as “attractive and highly sophisticated products that can help you meet. . . Objectives. ” 20

Holding Companies Owner managers use holding companies to receive tax-free dividends from their operating companies. Serves to protect retained earnings and maintain small business tax status. The Problem: Trapped Corporate Surplus – Investment earnings in holding company taxed at high rate – Funds withdrawn taxed as dividends – Capital gains on shares (NOTE: Applicable also to professional corporations) Solution Strategy: 1. Before age 65 Reallocate funds to tax-exempt life insurance (as discussed) 2. Age 65 to 85 The Corporate Insured Annuity Solves problem plus retirement income for life 21

Corporate Insured Annuity A tax planning and investment strategy that involves the purchase of two financial instruments: 1. A guaranteed non-prescribed life annuity (without a commuted value) in order to maximize income available to the shareholder, and, 2. A corporate-owned life insurance policy in order to replace the invested capital and to maintain the value of the corporation. 22

Corporate Insured Annuity The corporation receives a regular payment comprising a blend of return of capital and interest. The taxable portion decreases each year. A portion of the after-tax revenue is used to pay the premiums for the life insurance policy new or existing. At death, the annuity payments cease, but the corporation receives the life insurance proceeds. Neither the annuity nor the insurance policy will have any value. 23

FINANCING THE ANNUITY PURCHASE Options: replace 1. Sell Existing Investments 2. Borrow (Leverage) 3. Use funds from Sale of Investments & Borrow to them – Triple Back-to-Back (“TBTB”) Options 1&2: Are seldom viable from a liquidity and taxation point of view. Option 3: The TBTB is the most viable and advantageous funding method and can be achieved either in an Operating Company or a Holding Company, depending on circumstances. Circumstances may dictate also that the annuity and life insurance are held separately in Opco and Holdco, respectively; the advantages of the TBTB are achieved by the flow of inter-corporate dividends and loans. 24

Corporate Insured Annuity. . . The corporation's capital dividend account (CDA) will be enhanced by the excess of the proceeds over the ACB of the policy. Tax-free proceeds can be paid to the estate through the CDA. Had this strategy not been adopted, any amounts paid by the corporation would be treated as an ordinary taxable dividend. Benefits The after-tax return for the corporation exceeds that on conservative investments (income for life). The ultimate capital gains realized on the shares is reduced. The credit to the capital dividend account allows the tax-free distribution of funds out of the corporation. 25

BENEFITS OF THE TBTB STRATEGY - Benefits 2 & 3 of the Corporate Insured Annuity, discussed above, are attained. The TBTB does produce additional after-tax cash flow without tying up any capital. - Substantial tax advantages 26

Probate Fees • Execute second will to dispose of assets not required probate e. g. shares of private company • Validity of multiple wills confirmed by the courts • Assets in joint ownership not subject to probate • Specific beneficiary designations on RRSP, RRIF, life insurance keep plans out of estate for probate purposes 27

Inter Vivos Trusts • Alter Ego trusts and joint spousal trusts – Allow tax deferred transfers or property – Keep assets out of estate for probate purposes – Avoids double payment of probate fees on the same assets • Weigh the probate fee benefit against the potential tax savings from income splitting through the use of testamentary trusts 28